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Discuss the usefulness to a business of a knowledge of price elasticity of demand and income elasticity of demand. [12]

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Introduction

Transfer-Encoding: chunked ´╗┐Discuss the usefulness to a business of a knowledge of price elasticity of demand and income elasticity of demand. [12] [PED YED already defied, in part a), no marks were awarded for knowledge on this essay] With regards to price elasticity of demand, the firm can derive much utility from knowledge of its values. Most importantly, it allows the company to make a well-informed decision in regards to pricing strategies in order to allow for a maximisation of revenue and profits. A high price elasticity of demand could indicate that there is potential for increasing revenue of the price is lowered, as, a high price elasticity of demand indicates a very strong consumer reaction to price changes, thus, if the price is lowered, the company can expect an increase in consumption that will outweigh the fall in per unit revenue. ...read more.

Middle

In terms of income elasticity, knowledge of its value can help the firm make better decisions in terms of production with regards to the economic cycle. If the income elasticity of demand happens to be relatively low and close to 0, then that indicates a very small correlation between incomes and consumption, meaning that the economic cycle is likely to have little to no effect on revenue. However, if the income elasticity of demand happens to be a particularly high value, be it positive or negative, then the firm should pay close attention to its output in relation to the economic cycle. If the product in question has a very high negative value, that would indicate it is an inferior good, whose demand increases with falls in income, thus the firm should aim to produce such a good during times of recession, where incomes are predicted to fall. ...read more.

Conclusion

This comes at an opportunity cost to the company and it could be argued that company funds would be better spend on other endeavours such developing new products or funding growth. Moreover, the use of such statistics can slow down the decision-making process within the business, thus limiting its ability to react to changes in the market and, as such, lowering its price elasticity of supply, which can hurt the firm?s ability to maximise revenue if the price of the product they are producing increases. Overall, while the knowledge of price and income elasticities can be invaluable to a firm as it helps the firm make better decisions in regards to pricing and the level and nature of their output, this is as long as the figures used are accurate, up-to-date and used in conjunction with other metrics by competent managers in order to be suitably and promptly interpreted and lead to a decision. ...read more.

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